Eva Ascarza

When Talk Is 'Free': An Analysis of Subscriber Behavior Under Two- and Three-Part Tariffs

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In many service industries, firms introduce three-part tariffs to replace or complement existing two-part tariffs. As opposed to two-part tariffs, three-part tariffs offer allowances, or “free” units of the service. Behavioral research suggests that attributes of a pricing plan may affect behavior beyond their direct cost implications and there is evidence that customers value “free” units above and beyond what would be expected based on the change to their budget constraint. Nonlinear pricing research, however, has abstracted from such an effect.

Using a unique data set, we analyze tariff choice and usage behavior for customers who switch from two-part to three-part tariffs. We find that switchers significantly “over-use” compared to their prior two-part tariff usage. They attain a level of consumption that cannot be explained by a shift in the budget constraint. We estimate a discrete-continuous model of tariff choice and usage that accounts for the valuation of “free” units. Our results show that 81.9% of three-part tariff users have a positive valuation for the new attribute. This translates into a 12.2% revenue increase.